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International risk-sharing and the transmission of productivity shocks

Giancarlo Corsetti (), Sylvain Leduc () and Luca Dedola ()

No 826, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to efficient risk-sharing, negatively correlated with cross-country consumption ratios. This paper shows that a standard international business cycle model with incomplete asset markets augmented with distribution services can account quantitatively for these properties of real exchange rates. Distribution services, intensive in local inputs, drive a wedge between producer and consumer prices, thus lowering the impact of terms-of-trade changes on optimal agents' decisions. This reduces the price elasticity of tradables separately from assumptions on preferences. Two very different patterns of the international transmission of positive technology shocks generate the observed degree of risk-sharing: one associated with improving, the other with deteriorating terms of trade and real exchange rate. In both cases, large equilibrium swings in international relative prices magnify consumption risk due to country-specific shocks, running counter to risk sharing. Suggestive evidence on the effect of productivity changes in U.S. manufacturing is found in support of the first transmission pattern, questioning the presumption that terms-of-trade movements in response to supply shocks invariably foster international risk-pooling.

Keywords: International finance; Consumption (Economics); Foreign exchange rates (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge
Date: 2005, Revised 2005
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Related works:
Journal Article: International Risk Sharing and the Transmission of Productivity Shocks (2008) Downloads
Working Paper: International Risk Sharing and the Transmission of Productivity Shocks (2004) Downloads
Working Paper: International risk-sharing and the transmission of productivity shocks (2004) Downloads
Working Paper: International Risk-Sharing and the Transmission of Productivity Shocks (2003) Downloads
Working Paper: International risk-sharing and the transmission of productivity shocks (2003) Downloads
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